The Multi-Timeframe Liquidity Tracking Guide
THE MOST IMPORTANT FUNDAMENTAL is liquidity.
Congratulations. This simple mental model puts you leaps and bounds ahead of the game. (It’s amazing how few truly understand liquidity…)
But now that you know the basics of the most important fundamental, you now need to know how to apply that information to make money.
Our team uses fancy, expensive financial terminals that give us access to 10s of millions of obscure data sets and information sources. For a data geek like myself, it’s pretty awesome. We have a whole suite of dozens of proprietary liquidity indicators that we share with our Operator Collective. They give us all a leg-up on the market.
But as nice as this information is — and it is nice — I can show you how to get 80% of the same results using only free data sources.
I’m going to show you 3 liquidity indicators that’ll help you spot the next market steamroller. That way you can calmly sidestep into becoming a trader pancake.
You’ll also learn to clearly see when the liquidity spigots are firehosing markets, signaling a profitable time to jump in. (This typically occurs as the rest of the market scrambles to sell at the exact bottom of a move.)
Before we start, I want to share three quotes that make up the basis of our approach to trading: “Things should be made as simple as possible, but not simpler.” ~Albert Einstein
“The market is a mathematical hypothesis. The best solutions to it are the elegant and the simple.” ~George Soros
“That's been one of my mantras — focus and simplicity. Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it's worth it in the end because once you get there, you can move mountains.” ~Steve Jobs
Simplicity is beautiful. It makes you money.
It’s a human tendency to believe that complex solutions are superior to simple answers when operating in a dynamic environment.
This is wrong.
Oftentimes traders shovel complexity into their process because they’re ignorant of the problem they’re solving for… or the question they’re answering.
They use complexity to disguise their ignorance.
We don’t do that at Macro Ops. Instead, we adhere to the KISS principle:
KEEP IT SIMPLE STUPID
Our three liquidity indicators embody this principle. They’re simple, logical, and more importantly, they work.
We’re going to start from the top time frame and then move lower. You’ll learn how to gauge:
➢ Long-term liquidity that’ll help you sidestep entire bear markets
➢ Mid-term liquidity that’ll show you how to spot large counter-trend selloffs
➢ Short-term liquidity that’ll reveal the market’s path of least resistance over a multi-week timeframe
Long-term Liquidity — US Leading Index
This is the Leading Index for the US. It’s released monthly by the Philadelphia Fed.
Here’s the link to this chart in FRED, which is an awesome free economic and market data website maintained by the St. Louis Federal Reserve.
The following is a quick summary of what the Leading Index monitors via the FRED website:
The leading index for each state predicts the six-month growth rate of the state's coincident index. In addition to the coincident index, the models include other variables that lead the economy: state-level housing permits (1 to 4 units), state initial unemployment insurance claims, delivery times from the Institute for Supply Management (ISM) manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury bill.
There are many liquidity components that make up this indicator.
You have housing demand which is tied to mortgage rates; unemployment claims that are tied to the Fed’s dual mandate (which determines the direction of their monetary policy… the biggest liquidity lever of them all), and the interest rate spread which moves based off liquidity and inflationary pressures amongst other things.
It’s a highly effective long-term, cyclical liquidity indicator.
As you can see above… it works.
The index has collapsed before every one of the last four recessions (for which there is data)
A falling blue line means cyclical liquidity conditions are tightening. Tightening liquidity is bad for stocks.
The level you want to watch, which is marked in red on the chart above, is the 0.7% line. This is the demarcation line. If the index crosses below, it means a bear market is stampeding in your direction. You should either go into cash or be net short the market.
Following this one indicator will cut off the killer left-tail drawdown and ensure you compound your returns over the long haul — which is the only true secret to this game.
Mid-term Liquidity — US High Yield CCC or Below Option-Adjusted Spread
This is the BofA’s Merrill Lynch US High Yield CCC or Below Option-Adjusted Index. It tracks the spread between the interest rates on junk debt (low-quality, risky debt) and the interest rates offered on similar duration treasury bonds (which are viewed as high-quality, risk-free debt). You can find the index on the FRED website.
Credit always leads equities.
Remember, the availability and pricing of credit is a direct lever on liquidity. That’s why it’s so important to track the CCC index, which is the pricing of credit risk over treasury bonds.
I love this indicator and check it every few weeks. It gives me an intermediate view of liquidity (1-6 months) and helps me consistently sidestep large market pullbacks, as well as identify when it’s the right time to be a buyer.
The key with this indicator is disregarding absolute levels. These fluctuate over time depending on the current macro regime.
We care about the relative change. Specifically, a move higher of greater than 3% signals instability ahead for markets.
Trend is also important. An uptrending CCC index is bad for equities and a downtrending one is good.
For example, take a look at the chart below showing the last large counter-trend selloff in markets from late 15’ through early 16’.
The CCC index signaled it a few months in advance.
If you were one of the few who understood liquidity and tracked indicators like the CCC, not only could you have shored up your long exposure, but you could have loaded up on short-term SPX put options and made a small killing (just like us).
You then could have used this leading index as a signal the selloff was over. Once the blue line started downtrending for a while, you could have jumped back into markets. A downtrending CCC index means improving liquidity, which is good for risk assets like stocks.
Short-term Liquidity — High-Yield Bond ETF (JNK)
The SPDR Bloomberg Barclays High-Yield Bond ETF (JNK) is a simple junk bond ETF. (HYG is comparable and just as useful.)
Like the CCC index, this high-yield ETF tracks investors’ appetite for credit. It’s a good indicator of short-term liquidity (1-5 weeks) because we can see real-time oscillations when the market is open. You can track this ETF with any charting software. (We prefer www.tradingview.com as pictured above.)
The chart above shows the daily SPX with JNK marked by a red line. This goes back to the idea of “credit leads” — liquidity always shows signs of flooding or evaporating before a market move.
You can see on the chart that JNK (red line) tends to turn and trend down before a market selloff and trend up before a move higher.
This indicator is obviously noisier than the previous two, but that’s a function of dropping down to a short-term timeframe. It’s still an invaluable tool to track liquidity on a daily basis.
The goal is to look for trend divergences. At the time of this writing, JNK has diverged from the S&P and trended lower. Unless it quickly turns, the odds are the market will see a selloff. Pretty cool, huh?
I’ve just shown you 3 powerful tools to gauge liquidity and use it to make money in markets. Applying what you’ve learned here will put you miles ahead of the competition. Even some of the largest money managers don’t really understand this stuff…
Take it and run with it. And let me know how it helps your process. Just shoot me an email at firstname.lastname@example.org
See you in the markets.
Your Macro Operator,